In the digital age, do-it-yourself (DIY) apps and online guides have been created for . . . just about everything. Want to fix your car? Build your own computer? Learn to scuba dive? Compare used car prices? There is likely an app for it.
Of course, a certain amount of hands-on practice or expert guidance may still be necessary in some cases (for example, it would probably be rather foolish to study driving online and then go take your driver’s test without ever actually driving a car).
So you see, In industry after industry, the rise of money making apps and apps that save you money, has created an environment where, to the extent a service or product can be provided at a lower cost and with similar or better results using the internet, it will be.
Robo advisors are an example of this phenomenon. By using algorithms to provide personalized investment allocation advice based on your financial situation and risk tolerance, they provide you with a lower-cost alternative to hiring a human investment advisor.
Robo advisor services tend to be especially appealing to millennial investors who are used to doing things online themselves – a robo advisor, unlike a human advisor, can’t try to get you to change your mind about your investment approach or, in extreme cases, churn your account by making a lot of trades simply to generate revenue for the advisor.
Don’t get us wrong, this is not to say that it is not appropriate to seek investment advice from a human advisor at times, just that many modern-day investors prefer to control when and under what circumstances such interaction takes place.
Some robo advisors enable this by taking a hybrid approach, allowing investors who pay a higher fee or invest a certain amount of money access to human advisors.
Whatever the type, robo advisors have experienced tremendous growth in recent years. With stand-alone robos (as they are colloquially called) leading the way at first, and hybrid robos coming on strong over the last year or so.
The Growth of Robo-Advisors
A report by Ipsos shows that users of robo advisors worldwide increased substantially from 2015 to 2016, growing from 2.8 million to 5.7 million. Assets under management (AUM) grew from $66 billion to $126 billion over the same period. Another report, by BI Intelligence, predicts that robo advisors will manage approximately $1 trillion in 2020, and in the area of $4.6 trillion by 2022. My Private Banking Research, in their report on the industry, projects that the growth of hybrid robos will outstrip that of stand-alone robos going forward.
The growing popularity of robo advisors has been driven by a variety of factors, including their ability to offer investment allocation advice at lower fees than the typical human advisor and the convenience of establishing and managing accounts online. Other benefits offered by robos include automatic portfolio rebalancing, tax harvesting, and the ability to access an account across multiple devices.
Who is using robo advisor services?
Investors of all types, wealthy and not-so-wealthy, experienced and neophyte. There are, however, certain types of investors who these robot digital asset managers seem ideally suited for, including:
Often highly tech savvy, many of them tend to distrust existing financial institutions and their personnel as a result of the great financial crisis.
In addition, millennials are comfortable performing a variety of tasks online, including managing their finances. Using a robo advisor is an extension of this process, enabling you to invest without having to pay a human advisor’s (at times hefty) fees, not to mention the risk of hiring an advisor who gives you bad advice.
While a robo advisor’s advice is not guaranteed to be good, of course, it will typically be based on algorithms using historical data to maximize an investor’s performance given certain parameters – such advice can offer a baseline investment approach which you can choose to accept or reject, rather than having a human advisor make such decisions for you without your knowledge.
Another group that can benefit from robo advisors are investors who are just starting out without a lot of money to invest – if this describes you, a robo advisor can provide you with professional advice you might not be able to afford if you tried to hire a human financial advisor.
Robo advisors typically charge from 0 to .60 percent for their services, while human advisors usually charge between 1 and 3 percent, giving the robos an edge when it comes to fees. If you are an investor who doesn’t need hand-holding or other input from a human advisor, using a robo can result in significant cost savings over the long run. As long as the underlying returns are comparable, this can translate into improved investment performance.
The hybrid robo advisor model has been gaining in popularity recently, partly because it allows financial advisors to focus on client service, rather than building investment portfolios. Using this technology to operate more efficiently enables them to increase the number of clients they can work with, ultimately increasing their earning potential.
Let’s take an in-depth look at Betterment, one of the most popular robo advisory services currently available. The company launched its business at the 2010 TechCrunch Disrupt conference, where its plan to offer a digital investment advisory service was praised as a way to help investors who were either underserved by or reluctant to use traditional investment advisory options such as financial advisors or stockbrokers.
From that time, the company has experienced tremendous growth, ultimately becoming the leading stand-alone robo advisor in the country as measured by accounts under management (AUM). The company’s success saw it attract more than $30 million in capital in 2014 to help fund its growth. The company currently has over $7 billion in AUM.
How does Betterment work?
Betterment operates by getting data about you and your financial situation and investment objectives through a questionnaire which prompts you to provide information such as your risk tolerance, time horizon (how many years before you need to start withdrawing money from your investments), and investment objectives.
Betterment’s algorithms use this data to come up with investment allocation recommendations tailored to your situation. The process can be completed entirely online, making it attractive for investors used to conducting their personal affairs in the digital realm.
The service allows users to take advantage of as much as 1 year without paying management fees, and thereafter charges a 0.25% fee per year for users of its Digital plan.
There is no minimum account balance to open an account. All clients receive access to Betterment’s digital services including automated portfolio management, strategies for tax efficient investment, and investment allocation advice.
Investors who want access to a yearly call with Betterment’s team of financial experts can sign up for Betterment Plus if they have at least $100,000 invested. The annual fee on these accounts is 0.40%.
For a fee of 0.50%, along with a $100,000 minimum balance, you can sign up for the Betterment Premium plan to gain unlimited access to Betterment’s CFPs (certified financial planners) and other financial experts.
Betterment Account Services
Investors using Betterment can set up a variety of types of accounts, including individual, joint, traditional IRA, Roth IRA, rollover IRA, SEP IRA, non-profit, and trusts.
A variety of account services are offered, including:
- Automatic rebalancing: Betterment automatically makes transactions in your account as necessary to bring it back into balance with your selected asset allocation model.
- Tax-loss harvesting: This feature enables Betterment to use losses in your taxable account to improve your after-tax returns.
- Tax-coordination: A process which allows Betterment to allocate your assets as efficiently as possible taking into account both your tax-deferred and taxable accounts.
- Retirement Calculator: This feature allows you to connect your retirement accounts in a linked grouping to enable Betterment to help you plan for retirement.
- SmartDeposit: Using this service allows you to automatically deposit funds into your Betterment account if your bank account balance exceeds a certain amount.
- Two-Factor Authentication: This feature helps increase your Betterment account’s security via the use of an app or text message to authenticate logins.
Modern Portfolio Theory
Betterment uses an investment strategy called Modern Portfolio Theory (MPT) to manage client assets. MPT attempts to provide the maximum returns possible for a given level of risk. It accomplishes this by diversifying funds across a variety of assets and asset classes, which acts to reduce risk and stabilize performance over the long term.
Nevertheless, all accounts are subject to market risk, meaning that during bear markets even a diversified portfolio is subject to losing money. The service uses ETFs (exchange-traded funds) instead of individual stocks or bonds to invest its clients’ funds. These investment vehicles enable Betterment to easily diversify your funds across various sectors and geographic regions.
Betterment Portfolio Returns
Betterment reports that its Betterment portfolio consisting of 70% stock would have returned 6.4% on average per year from January 2004 through May 2017, which equates to a 130.00% cumulative return over that time. On its website, Betterment claims that a private client investor undertaking similar risk over the same period would have realized a return 50 percentage points below the 130.00% its account returned.
Betterment Portfolio Options
The main Betterment Portfolio uses world markets as its baseline, helping to widely diversify risk by investing globally. The service also offers a variety of other portfolios, including socially responsible investing, generation of a target income, and using a smart beta approach to attempt to do better than the market. Each portfolio is available at the individual goal level, and is adjusted in accordance with your personal financial parameters such as income requirements and time horizon.
Betterment vs Vanguard
Vanguard Personal Advisor Services is a full service robo advisor run by the massive Vanguard mutual fund company, which has around $3 trillion in AUM overall. Its minimum account balance of $50,000 keeps use of the service out of reach for many beginning investors, unlike a robo such as Betterment which has no account minimum. Its fees are comparable with Betterment, running 0.3% per year.
All of its users have access to human advisors, giving it a price advantage in this regard as compared to Betterment, which charges 0.50% for on demand advisor access. Its human advisors are also more proactive, reviewing accounts from time to time as well as being available to answer investor questions. The fee remains level no matter how much you have invested in Vanguard Personal Advisor Services. As with Betterment, Vanguard offers portfolio rebalancing, the ability to make automatic deposits and a mobile app.
Betterment vs Wealthfront
Wealthfront is a major competitor that offers many of the same services and features that Betterment provides. It has a minimum account balance of $500, while Betterment has no minimum, however, the minimum is low enough that this is not a major point of distinction between the two robo advisors.
Wealthfront offers a 0% management fee to investors with less than $10,000 invested, making the service very attractive to investors with between $500 and $10,000 to invest.
Wealthfront offers direct indexing to investors who invest more than $100,000, a service that is not offered by Betterment or other competing robo advisors. This service enables Wealthfront to utilize your individual securities to search for opportunities to engage in tax-loss harvesting. This functions as an additional method for making use of tax losses along with the tax-loss harvesting on a daily basis Wealthfront provides for all taxable accounts, making the robo an attractive choice for investors with large taxable account balances.
Wealthfront’s fees of 0.25% after the first $10,000 are competitive with Betterment, and it’s AUM of $5 billion places it close to its larger competitor in size.
Betterment vs Acorns
Acorns is an app designed for spare-change investment, which differentiates it from full service robo advisors such as Betterment. It links to your bank account as well as your credit cards, and rounds up daily purchases and invests the excess “change” in a portfolio made up of a diversified basket of ETFs.
Acorns is ideal for younger and new investors looking to get a start in the investing arena. Acorns charges $15 a year for investors with less than $5,000 invested and a management fee of $0.275% for accounts above that amount.
The service offers 5 investment baskets, ranging from conservative to aggressive. The amount you “round-up” for each transaction can range from $.01 to $1.00. For instance, if you made a purchase for $3.64, $.36 would be rounded-up to your account at Acorns.
While Acorns doesn’t offer the full retinue of services a robo advisor like Betterment can offer, its ability to link investing to daily financial transactions makes it an excellent tool for beginning investors. You might try Acorns as a first step in the investing arena, and then use a more full-featured service like Betterment instead of or in addition to Acorns when you are ready.
The robo advisor revolution is still in its early stages – as the sector matures and its offerings become more accepted among investors we should see many of its innovations become commonplace in the financial industry. As an investor deciding whether a robo advisor is the right choice for you it is important to understand the key advantages such services provide, including:
- Algorithm-derived personalized investment allocation advice tailored to your financial situation
- All electronic application and account management services
- Tax-loss harvesting to maximize the investment efficiency of taxable accounts
- Automated portfolio rebalancing
When it comes to choosing a specific robo, Betterment, as the largest stand-alone robo advisor currently, is a solid choice. It offers investors with large and small accounts the opportunity to invest at low cost and take advantage of low account management fees and other helpful services.
Its competitor Wealthfront offers many of the same services, with the main point of distinction between the two robos being the ability of Wealthfront to offer extra tax-loss harvesting services to investors with large taxable account balances. Vanguard’s robo offers comparable services, with a somewhat lower management fee for investors with large accounts who also want to be able to speak with human advisors. However, its high minimum account balance of $50,000 makes the service inaccessible for many beginning investors and investors with small accounts.
Acorns offers a helpful introductory investing experience for beginning investors, however, it doesn’t have the complete panoply of services that a full service robo advisor like Betterment offers. For investors new to investing, however, it can be an excellent tool to get started.
If you are looking to take advantage of the benefits of robo investing, all four of these services can be excellent choices, depending on the amount you plan to invest and the type of investing you plan to do.
Use this review along with visits to the services’ websites to determine which robo advisor seems best suited to meet your investing needs.